Incorporating alternative assets into your portfolio

This article is part of
Guide to Multi-Asset

Alternative assets also contribute to portfolio returns when the markets are not moving upwards and many investors use alternative assets as a counterbalance to falling markets, as they are not reliant on market performance.

Tim West, UK alternatives leader at EY, says: "Professional investors use sophisticated tools to measure the risk-return profile of alternatives to get the right balance.

“When looking to alternative investments, the potential for higher returns must be weighed against the higher fees charged by the investment manager. In some structures, the manager may co-invest alongside the investor and be entitled to performance fees – this alignment is seen as an extra incentive for the manager to outperform.”

Alternatives are not just necessarily a ‘defensive play’ to balance investors’ portfolios. Instead, they seek out returns linked to a non-traditional asset or investment strategy and can provide strong returns, according to Lane Prenevost, global head of discretionary asset management and head of UK multi-asset at HSBC Global Asset Management.

“Alternatives can increase returns by offering access to an illiquidity premium, which is most common in private markets, such as real estate or private equity. These assets often embed leverage, increasing returns, but also of course potential losses,” he says.

“Alternative asset classes may benefit more than equivalent public markets from active management, where there is product complexity or information asymmetry, as is the case for private credit markets or unlisted infrastructure. Option writing also offers the ability to increase portfolio income, which is really useful for investors looking for yield in their portfolios.”

However, according to FE Investments’ Younes, investors should not be fooled into thinking of ‘alternative assets’ as a single asset class in their own right.

He argues that the view that assets are either ‘traditional’ or ‘alternative’ and that all alternatives perform and behave in the same way in all market conditions is a mistake. One year ago, when markets were falling, some alternative assets that were geared towards certain market conditions performed very well, while other alternatives performed very badly.

He says: “Looking at the IA Targeted Absolute Return sector we see huge disparities in performance. Although the sector has averaged a negative performance of -4.86 per cent (relative to a -30 per cent fall in equity markets), funds like Argonaut Absolute Return, AQR Managed Futures or Allianz Fixed Income Macro were positioned to benefit from a sell-off in credit and equity markets and generated strong positive returns.

“Conversely, funds like Natixis H2O MultiReturns or GAM Star Global Rates took too much directional risk and fell in line with traditional asset classes.”

Fraser Harding is a freelance journalist